We’re witnessing a new trend in alternative investing, yet it is not being generally documented unless you read ValueWalk.
New category for “hedge fund intimidation”
That trend is hedge fund intimidation, a new category to sit alongside distressed arbitrage, managed futures, quantitative investing and volatility being traded as an asset class. In other words, those niche strategies typically uncorrelated to the stock market that often operate in the shadows, with even professional investors not understanding the intentionally designed “complications” that obfuscate how money is really made.
But when you break down this new intimidation strategy much in the same way you analyze a hedge fund strategy, investors can pinpoint the critical components that underlies success.
Buffett: “CEOs are terrified”
To understand the strategy, first observe the goal. The effectiveness of this new strategy was on display in headline fashion on Wednesday as Warren Buffett, who is said to run his life out of LA more than Omaha, noted the end effect:
“CEOs are terrified of activists,” he blurted out on CNBC, an amazing validation for the Carl Icahns of the world.
The goal of the strategy is to terrify a board much in the same way a cartel might terrify a prosecutor. The tactics used to achieve the goal vary from hedge fund investor to hedge fund investor, with differing levels of effectiveness that is sometimes correlated to the regulatory connections and blood tactics one might use.
The Icahn hockey fight
The most vocal, chalkboard-scratching category might be considered Icahn’s hockey fight approach: your reputation for dropping the gloves on a personal level and drawing blood in a street fight is your currency to success. The idea is to win the battle before your blades touch the ice. In Icahn’s case he terrifies board members on a personal level. Being appointed to a corporate board confers a significant degree of distinction to a business career – and along with it a degree of social status. What Icahn does is go after a board member’s personal reputation, much like he did in the eBay Inc (NASDAQ:EBAY) proxy fight where he impugned the reputation of Silicon Valley tech pioneer Marc Andreessen.
The message is clear. Just like a cartel going after a prosecutor’s family, the Icahn reputation is that when he’s trying to get something from a board of directors they better listen… or else. Icahn’s TV demeanor plays right into this, as he appears at times a cross between Queens mechanic, identifiable when he speaks, and a Neapolitan strategist with a strong sense of battlefield market environments and a genius at maneuvering his chess pieces at the appropriate time. This could be why he recently let it slip that he is instituting an “Icahn cubs” program where he would identify hedge fund protégés and seed their “investments.” It is unclear how he is identifying new talent to emulate his activist hedge fund strategy. One might think he would head to the brawny parts of Rockaway, Queens enter a local bar and throw $1,000 on the floor. The man who pulverized his way to gain possession of the easy cash could be Icahn’s next mentor project.
The Ackman behind-the-scenes power play
A more subtle iteration of the hedge fund intimidation strategy is practiced by William Ackman. His strategy uses fear, but not in the board’s personal life but in their corporate survival. Ackman’s subtle message is: If you have any issues that might be of the slightest interest to a regulator, I have the connections to bring you down. This is on display in the regulatory pile-on Ackman is documented to have lobbied for in the Herbalife example. As the alphabet soup of corporate trouble descends on the multi-level marketer Herbalife Ltd. (NYSE:HLF), with the FBI, FTC, SEC and New York and Illinois Attorneys General leading the charge, Herbalife’s potential descent could be a flash crash like none other if one of these pit bulls let loose on Herbalife find any meat on the bone.
Ackman recently enhanced this reputation with the investment in the behind the scenes former SEC enforcement muscle Robert Khuzami. Khuzami’s tough guy reputation, having prosecuted drug cartel criminals at the US Department of Justice, is tainted in the eyes of some insiders because he allowed bank cartel members to escape without much fanfare. But perhaps that’s the point and part of his tough guy reputation: he interprets the law and who it applies towards.
When activist fund manager Ackman hired Khuzami in regards to the controversial strategy to buy derivatives of a stock when you had likely information that stock was about to be acquired, Khuzami’s declaration the insider trading strategy was legal seemed to be the definitive word on the topic. Looks like insider trading, but Khuzami, now in private practice where his post-SEC salary is a record $5 million per year, cleared the air. “If anyone at the SEC has a problem with this, they can talk to me,” he bellowed. In other words, despite the fact I’m in private practice, I still interpret SEC enforcement guidelines and those who oppose me are breaking the code of silence.
This is the Ackman intimidation strategy and it has an amazing Sharpe ratio: no downside risk to measure since he began in this direction close to a year ago – with excessive upside volatility, which is to be expected.
The Winters Midwestern play is a loser
Then there is David Winters, sort of the club outsider to this activist game. Unlike Icahn and Ackman, which appear held to a different standard, Winters has been questioned as a gadfly and dismissed at times.
Winters’ strategy has been sort of a play by old school rules of polite corporates in that he didn’t make his recent attacks on The Coca-Cola Company (NYSE:KO)’s board or management personal. He didn’t call out specific board members as corrupt nor did he impugn the reputation of individual managers at Coke. He doesn’t have the regulatory and investigative muscle, nor the inside connections and money this requires. What he had was an academic thesis that was proven generally correct. Even establishment burdened Warren Buffett said Coke’s executive management plan, which Winters opposed, was “excessive.”
In other words, Winters ran a rather “clean” campaign by today’s standards. What did this get him? Scorn in the media and failure at the ballot box.
CNBC’s Jim Cramer said Winters had little right to question Coke’s establishment because he didn’t have enough money under management. In an exchange on CNBC April 15, Cramer joked he had more shares of Coke than David Winters, which led Andrew Ross Sorkin to question: “Do you think with activist investors we should care what their stake is or what their argument is?”
“I care about the (track) record,” Cramer said. “I care about how much money they have, I care if they want to get on the board and have a right to get on the board,” Cramer said. “I don’t care if they are pop-offs who have no say and are insulting to people like Muhtar Kent who has been a great executive who has done a fabulous job. I respect Muhtar Kent and I think sometimes these guys who don’t have a lot of capital shoot their mouth off ought to respect some of these great CEOs. They deserve our respect.”
“I’ve never seen anything like this,” David Winters said in a previous interview with ValueWalk, referring to the Coke management compensation package. “It is stunning. It would be one thing if Coke was growing at 40%, but this is a mid single digit grower (and doesn’t warrant such an aggressive bonus package).”
There he goes again, using a fact based intellectual argument. When will he learn?
Winters’ “play by the rules of civilized society” strategy is least appreciated and most despised by the Wall Street police, it appears.
